My thoughts on crypto at the end of 2021

Or: Icarus is back

Disclaimer: This is an opinion piece. No guarantee of completeness or correctness. This english version is proudly presented by Google Translator

Cryptocurrencies are still on everyone’s lips. The pandemic has massively increased interest, in a way adaptation, but above all trading volume. Acquirers, credit card companies and even banks and asset managers who tend to be conservative are succumbing to the dubious success of this (actually not) new technology - including with their own crypto funds. Since surely everyone knows the saying “If even your hairdresser gives you stock tips, it’s time to get going” and this bizarre situation has existed for some time, I would like to share my critical thoughts on the crypto industry. The saying should not be taken disrespectfully towards the hairdressing trade, but rather illustrates the fact that when the general public is making, or appears to be making, disproportionate profits, we are already mathematically in a “bubble”.

To put it bluntly - I personally see great advantages in technologies of decentralized consensus building, i.e. what, for example, blockchain or tangle graphs were created for. However, these advantages are different from the repeatedly mentioned transparency, anonymity, better data security, better security or the proclaimed faster speeds. On closer technical examination, apart from the storytelling of the white papers, the advantages mentioned often neither exist nor are there any real advantages, sometimes even massive disadvantages.

Let’s take a quick look at the basic difference between centralized consensus and decentralized consensus:

In the case of a means of payment or currency, there is a bank at the central consensus that ensures the consensus, i.e. who has how much money in the account. The bank keeps a book in which all transactions are listed. Confidence in the monetary system is therefore directly dependent on the conscientious business conduct (i.e. proper bookkeeping) of the bank. The conscientious business conduct of the bank, in turn, is directly dependent on the conscientiousness of the government and the legal certainty of the respective state.

In the decentralized case, no bank is needed, instead a group of citizens is appointed, each of whom keeps a parallel record of all transactions (the so-called miners). The miners receive compensation for this service (block reward). Of course, this means a certain amount of overhead, since instead of one central book, 20 books, for example, now have to be kept. In addition, if the books have different entries, a decision must be made as to which books are “right,” so a consensus algorithm must be developed.

“Crypto provides more data protection”

Using the visualization just mentioned, which is closer to technical reality than you might think, some thought experiments can be carried out to get a better idea of the advantages and disadvantages of cryptocurrencies. For example, it is easy to ask whether data protection is increased if personal data, whether unencrypted or encrypted, can be attacked in potentially 20 different places than in one place. This is not the case. The data is safer from manipulation for the price of data protection. You probably know for yourself whether your house bank has ever manipulated your transaction data and whether you are willing to put an end to this foolish manipulation by disclosing all of your private transactions. I am not. I have a lot of criticism of my bank, but not in this direction.

“Crypto provides more anonymity”

It is also easy to answer the question whether cryptocurrencies mean anonymity and the answer is: no, they mean the opposite. Instead of a bank with banking secrecy and high judicial hurdles for access, cryptocurrencies mean ruthless transparency about every transaction that exists. In contrast to the existing system, this means that everyone knows at all times who transferred how much to whom and when, and who has how much in their account when. Contrary to what is widely assumed, cryptocurrencies can only be acquired anonymously with a great deal of criminal effort. All exchanges, as well as the stock market, are obliged to verify identity. In this sense, transparency is undoubtedly a property of cryptocurrencies, but the question is whether it is an advantage if private financial transactions are freely accessible or whether it makes one a transparent citizen.

“Crypto provides more security”

To refute this argument, I need to explain a bit about the technical consensus algorithms. In contrast to our example, in practice not all books are compared and a consensus is determined from the majority, but - please hold on - the citizen who can go round in circles the fastest has the right book as intended. You are now familiar with the so-called Proof of Work algorithm. A new algorithm, described as revolutionary, aims to replace this with the groundbreaking idea that the citizen who has the most money in their account owns the right book. Now you may be wondering if I’m making bad jokes, but unfortunately I’m not kidding. The so-called Proof of Work algorithm, currently the most widely used consensus algorithm, requires solving very difficult differential equations that have nothing to do with currency. The inventors of the algorithm assume that someone who is able to solve an algorithm faster is also more trusting. The more power a computer has, the faster it can calculate this equation, in our example this is the power in the leg of the citizen who is turning in a circle on the spot. This algorithm, who would have guessed otherwise, has already failed in practice - with resets and hard forks as a result. Not to mention the massive waste of resources and the associated emissions. The highly acclaimed successor to Proof of Work is Proof of Stake, where as mentioned, the richest determine the consensus – another very original proposition from the crypto scene. This part of Krypto reminds me of the emperor’s new clothes. No one sees the point or can substantively defend it, but everyone is talking about it.

“It can’t be that simple that so many people put their money into such an immature technology. So I must be missing something. I want to be there and also make profits. Doge to the moon!” Almost every crypto investor

“Crypto is decentralized”

Even decentralization is just a marketing term for some cryptocurrencies, rather than a living technical reality. Unlike other technologies that are invented in the first step and applications result from them in the second step, the application for many cryptocurrencies is already proclaimed before the technical challenges have been planned or even found to be feasible. This is also the case with the well-known “IOTA” currency, which is based on a tangle (instead of blockchain). Although the creators seem so confident in their technology that it’s been dubbed the “future currency of the Internet of Things,” they haven’t embraced the technology yet. Although there are decentralized nodes in theory, the IOTA Foundation operates a central coordinator node that has to verify every transaction, i.e. IOTA is currently a central bank that would like to become decentralized in the future with a technology that is still to be developed. It must also be mentioned that IOTA, like many other cryptocurrencies, has had technical weaknesses in the past. But even with other cryptocurrencies, the actually practiced decentralization is questionable due to so-called “mining pools”. Mining pools bundle mining capacities commercially, so that a large part of the available mining power lies with individual actors who may have self-interests. In the past, this allowed so-called “Sybil” attacks to be carried out, in which the blockchain was manipulated to the advantage of the miner.

“Crypto is faster”

This argument can be invalidated as of 2021 with our initial example. Decentralized cryptocurrencies currently require more resources than centralized currencies for the same number of transactions, which is quite logical. A central posting triggers the entry in 1 “book”, a decentralized posting with n nodes triggers the entry in n books. Even with non-blockchain-based cryptocurrencies such as IOTA, each transaction is confirmed by at least 2 other transactions, i.e. decentralized cryptocurrencies have usually been slower with the same resources.

Then why is everyone working with crypto or announcing projects?

Without wanting to directly compare the majority of crypto companies to Wirecard, remember who all proudly announced partnerships with this gang of thieves? With so much money lying around, it’s worth getting your hands dirty. There is competition in every market, which creates the necessary pressure and forces to arbitrate the misunderstandings that have turned into money in the crypto market. Does Mastercard have a problem with dropping its affiliates like a hot potato when the crypto bubble pops? The past says no.

Everything bad? No way!

Before I get the impression that I’m a cryptopessimist, I would like to give two examples where, in my opinion, crypto brings real advantages, i.e. accelerating or improving existing processes or helping to save resources.

Examples: Some NFT’s and public administration

In my opinion, decentralized consensus is suitable for all applications where consensus is required on certain issues without a central organization being desired or where a central organization requires too many resources. An example are NFTs. NFT’s are entries on a blockchain that verify ownership of a certain asset. Examples are digital art such as images, videos or music, as well as assets such as clothing, land or skins in computer games or metaverses. Unlike financial transactions, NFT’s want ownership to be publicly viewable. In addition, there is no leading central authority that verifies digital assets, so most of these assets only emerged with the advent of decentralized accounting such as blockchain. Whether the current hype prices in the NFT sector are justified and whether NFTs for digital goods will prevail is another story. Another example would be the public land register. Instead of a city official having to rely on a purchase agreement to then manually enter the relevant changes into the land register, this could be done using a blockchain, which saves on resources. Notaries would act as miners, who would have insight into the blockchain, while the citizen could transfer his asset (the house) himself to the future owner, who would confirm this on his side with a transaction.

My point of criticism is not that decentralized currencies/accounting do not bring any advantages, but that the advantages in the current crypto industry are subordinate to the sometimes flimsy sales arguments, to the point that they sometimes do not exist at all. And that the current hype surrounding cryptocurrencies is not related to the merits of the technology and deep investor understanding, but presumably to a self-reinforcing mix of greed, cheap money and some degree of fraud.

As with shares: cobbler stick to your last. If you’re already feeling overwhelmed by the phrase “How to implement a hello world in C”, then you belong to the 99% of crypto investors who lack even the most minimal technical basics. You are gambling and you should be aware of that. If you’ve been able to win, be lucky and take it, but don’t make the mistake of succumbing to hot hand bias. Markets with such investors are nothing new and are a redistribution machine from the impatient to the patient. Personally, I’m concerned about the massive inefficiencies created for our economies by the resource allocation to crypto, and the diminishing ability to trust one’s own comprehension through greed. Because let’s be honest - everyone is aware of the situation inside.

My conclusion at the end of 2021

Most of the proclaimed advantages of the current cryptocurrencies dissolve on closer inspection

• Cryptocurrencies are not anonymous, nor are they privacy friendly
• As of 2021, cryptocurrencies are no faster than existing solutions
• Many current consensus algorithms are tamperable and have already been tampered with
• Most crypto investors do not understand the underlying technology and are driven by greed
• Cryptocurrencies can bring advantages for certain use cases